Commercial Mortgage Modifications: Lien
Priority, Title Insurance and Bankruptcy Issues Structuring Modification Agreements While Avoiding Legal Pitfalls
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TUESDAY, SEPTEMBER 25, 2012
Presenting a live 90-minute webinar with interactive Q&A
David R. Brittain, Partner, Trenam Kemker, Tampa, Fla.
Anthony A. Arostegui, Partner, Nossaman, Sacramento, Calif.
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Commercial Mortgage Modifications:
Lien Priority, Title Insurance and
Bankruptcy Issues Structuring Modification Agreements While Avoiding Legal Pitfalls
5
Commercial Mortgage Modifications: Lien Priority, Title
Insurance and Bankruptcy Issues
Anthony A. Arostegui Nossaman LLP, Sacramento, California [email protected] 916.930.7748
Loan Modification Objectives and Current Trends
September 25, 2012
6
• Popular Objectives With Loan Modification:
A. Extending Maturity Date; Extension Options
B. Adjusting the Loan Amount/Principal balance
C. Changing the Interest Rate
D. Revising Payment schedules and amounts
E. Adding or Releasing Security/Collateral
F. Modifying Disbursement Provisions to Restart Construction Project
7
• Preliminary Analysis for Loan Modification Request:
• Step 1: Determine Loan Status and Goals
― If default was beyond the borrower’s control, it may be worthwhile
for lender to work with the borrower
― If fault lies with the borrower, leaving the borrower in control may
not be an option
― What are the benefits of modification (either short or long term)
― Review long term market conditions
― Assess risk of lender liability and proper course of action (good faith
and fair dealing, written notices, opportunity to cure, etc.)
8
• Preliminary Analysis for Loan Modification Request (continued)
• Step 2: Assess Value of Collateral and Market
― Inspect to assess physical condition
― Obtain an appraisal or broker’s opinion of value (BOV)
― Review marketability of collateral
― Review leasing market
― Understand borrower’s prospects of project disposition
― If project generates income, assess timing for obtaining control over
funds
― If the loan is over-secured, lender may be more inclined to work with
borrower
9
• Preliminary Analysis for Loan Modification Request (continued)
• Step 3: Review Legal Documents
― Confirm completeness of loan documents
― Assess any defects in loan documentation (guaranty validity, etc.)
― Confirm proper perfection of lender’s lien
― Perform overall audit on loan
10
• Preliminary Analysis for Loan Modification Request (continued)
• Step 4: Evaluate Problems With Exercise of Remedies
― Mortgagee-in-possession
― Mechanic’s, judgment, tax or other liens
― Feasibility of operation of project by the lender
― Environmental issues
― Likelihood of success of modification
11
• Preliminary Analysis for Loan Modification Request (continued)
• Step 5: Assess Borrower’s (and Guarantor’s) Capabilities and Resources
― Financial resources
― Replacement of operator, tenant or franchisor
― Management skills
― Reputation, honesty and responsiveness to lender’s requests (for
example, assess if borrower stopped paying even when positive
project cash flows)
― Ability of borrower to refinance debt
― Capital infusion from either borrower or other equity source
― Guarantor’s commitment to project and financial resources
12
• Preliminary Analysis for Loan Modification Request (continued)
• Step 6: Require Adequate Agreements During Modification
― Pre-Workout Agreement
― Forbearance Agreement
― Loan Estoppel Certificate
― Detailed Term Sheet for Modification
― Price of Modification or Extension (fees, principal reduction, etc.)
― Other Assurances (guarantor consent)
13
• A. Extending the Maturity Date; Extension Options:
• Maturity default
― Borrower must continue to make monthly interest payments
― Each extension should be a limited term (no more than 12 months is
recommended)
― Automatic adjustments (clawback) to other terms in the event of any default
― Additional terms for extension:
― Increased interest rate (immediate or delayed)
― Payment of fees/points
― Additional security and/or collateral
― Additional covenants and performance standards/criteria for borrower
14
• A. Extending the Maturity Date; Extension Options (continued):
• Payment default
― Interest-only loans/interest-only periods
― Default in scheduled monthly principal and interest payments
― Unlike a maturity default, the payment default is cash-flow driven
therefore short-term solutions such as a reduction in monthly
payment amount may make more sense
15
• A. Extending the Maturity Date; Extension Options (continued):
• Extension Options
― The borrower’s default may have eliminated any extension terms
originally granted in the loan documents
― The completion by borrower of benchmarks upon which extension
options may be reinstated
― Additional options may be allowed upon the payment of a pre-
determined fee
16
• B. Adjusting the Loan Amount:
• Lenders are resistant to write down the principal balance
• Reliable valuation and income projections required
• Bifurcating the loan – A/B/C Note structures are more common (examples
include Note A as the “performing note”, Note B as the “Clawback Note”
and Note C as the “Deferral Note”)
• Temporary adjustments in monthly payment amount by changing the
payment terms are preferred by lenders
17
• B. Adjusting the Loan Amount (continued)
• Priority Considerations
― Optional versus obligatory advances
― Junior lienholders
― Intercreditor agreements
• Equitable Subrogation Considerations
18
• C. Changing the Interest Rate:
• Permanent or short-term reduction
• Adjustable or fixed rate
• Increased principal payments
• Payment of fees or points
19
• D. Modifying Payment Provisions:
• Reduction of monthly debt payments or forbearance
• Useful if collateral is currently generating insufficient cash flow, but
improvement is anticipated
• Reduced payment terms should operate for a limited period of time, the
original (or better) loan terms should then be reinstated
20
• D. Modifying Payment Provisions (continued):
• The lender can offset reduced payments by:
― Providing for a proportionate increase in the interest rate at the end
of the reduced payment period
― Negatively amortize the loan on a monthly basis in the amount by
which the original payments exceed the reduced payments
― Requiring additional security/collateral
― Taking an equity position in the property
21
• E. Adding or Releasing Collateral Securing the Loan:
• Adding new guarantors
• Requiring guarantors to provide collateral to secure their obligations
• Releasing of portions of the collateral (pad sites) for sale to tenants and
using the proceeds to pay down the loan
• Additional collateral
22
• F. Modifying Disbursement Provisions to Restart Construction Project:
• Special Problems with Construction Loans:
― Realizing repayment from an unfinished project is limited
― Sale of collateral will generate partial repayment at best
― If guarantor is not financially sound, prospects of repayment are further
diminished
― Third parties such as contractors and future tenants can file liens and institute
proceedings affecting the project
― Permanent lender will cancel its commitment upon default
― Default under such loans can be due to many sources, such as cost overruns,
poor construction management, poor design, poor project budgeting, force
majeure events, inability to secure permanent financing, inadequate rental or
sale market for product being constructed, etc.
•
23
• F. Modifying Disbursement Provisions to Restart Construction Project:
• Preliminary Considerations:
― What is the stage of construction
― What is the cost to complete the project
― Is the project bonded
― What is the status of mechanics’ liens
― What is the status of entitlements such as permits (current or expired)
― Is lender able to take possession and control of the project or must it institute
foreclosure proceedings
― Identify and assess all contractors and sub-contractors
― Assess probability of take out or permanent financing as a source of repayment
24
• F. Modifying Disbursement Provisions to Restart Construction Project:
• Additional Assurances for Further Disbursements:
― Prospects for tenants (i.e. cash flow)
― Lease commitments
― Completion of project
― Reduction of scope of work if possible
― Revise type of improvements
― Obtain completion guaranty from new partner
― New construction manager
― Raising additional equity
― Incurring debt through mezzanine financing
25
• F. Modifying Disbursement Provisions to Restart Construction Project:
• Modifying the Loan Provisions:
― Lender’ Agreement to Make Future Disbursements May be Dependent Upon:
― Amendments to the construction contract to revise cost of construction
― Revisions to the project budget to match lender’s commitment to make future disbursements
― Changes to the payment schedule
― Use of lender’s consultant to review contracts, budget and payments
― Receipt of “Will Serve” letters from contractor before making disbursements
― Agreement by borrower to make principal reduction payments upon specific triggers (such as sale of a condo unit in a condo project)
― Maturity Date: If lender agrees to fund the continuing construction of the project, the maturity date will need to be extended to permit the completion of the project and permit time for permanent financing.
― Additional Capital: Most stalled construction projects require additional capital to carry the project to a cash flow status. Lender will need to consider cooperating with borrower in obtaining other financing, such as mezzanine financing, in conjunction with the loan modification.
― Additional Security: Borrower will be asked to provide additional security such as additional collateral or a guaranty.
― Enforcement Mechanisms: Mechanics liens and stop notices can affect a lender’s lien. Lender will make sure that any advances are qualified as “obligatory advances” and obtaining an endorsement to lender’s title insurance addressing any loan modification and further disbursements.
26
Anthony A. Arostegui
Nossaman LLP
621 Capitol Mall, 25th Floor
Sacramento, California 95814
(916)930-7748 Direct
[email protected] | www.nossaman.com
27
COMMERCIAL
MORTGAGE
MODIFICATIONS:
KEY LEGAL
CONSIDERATIONS
David R. Brittain, Esq.
2700 Bank of America Plaza, Tampa, Florida
Fundamental Issues 29
What are the lender’s or borrower’s strategic
objectives?
What tactical actions or documents are
necessary to achieve those objectives (and
insure those objectives have been achieved)?
How do I prevent the adverse party or third
parties from interfering with achievement of
those objectives?
Modification vs. Forbearance Agreement 30
Loan Modification – preserves a lending
relationship by converting a non-performing loan
into a performing one, either immediately or over
time. Changes are to the loan documents
themselves
Forbearance Agreement – lender and borrower
recognize that the loan is non-performing and try
to maintain status quo while they look for a way
to exit the relationship. Creditor and borrower
execute an additional independent document.
Forbearance Agreement: Elements 31
Identification of the operative loan documents
and their status
Identification of any continuing lender
obligations and disposition (e.g., terminate
additional loan disbursements; pay-down on
note)
Acknowledge defaults by borrower
Provide for termination or expiration of notice,
grace, and cure periods
Forbearance Agreement: Elements (continued)
32
Identification of the purpose of the
forebearance and ultimate resolution (i.e., what
will be different six months from now?)
Release and waiver of key debtor claims and
defenses
Provision of assurances to lender (e.g., title
insurance down-date endorsements)
Limited restructure of business terms of deal:
extension of time, suspension of litigation.
Protecting Lien and Claim Priority 33
Whether modification or forebearance, how do we preserve lender’s first priority position against the collateral against competing claim?
Multiple competing claims: subordinate mortgages, construction liens, judgment liens, tax liens, etc.
Lien subordination: material modification of lender’s debt may cause gap in lien priority unless subordinate creditors confirm status quo.
Claim subordination: even if subordinate creditors agree to status quo, work-out may fail unless junior creditors agree not to seek or accept payments from borrower until senior creditor is paid.
Intercreditor Agreements and Lien/Claim
Subordination 34
Any form of intercreditor agreement adjusts
competing claims among creditors - key provisions:
No challenge to priority of lien
Confirm subordinate status of certain liens
No payments accepted or remedies pursued
against debtor until senior creditor paid (a/k/a
“standstill agreement”)
No or limited changes to subordinate creditor
documents, but changes to senior creditor
documents permitted
Intercreditor Agreements and Lien/Claim
Subordination (continued)
Cooperation by junior creditor in senior
creditor’s liquidation of collateral – how limited?
No assertion of rights of marshaling, equitable
subrogation, and other junior creditor rights
against senior creditor until senior creditor paid
in full
11 USC §510(a): a subordination agreement is
enforceable in bankrupcty to the same extent
that such agreement is enforceable under
applicable non-bankruptcy law.
35
Intercreditor Agreements: Typical Contested
Terms
36
Waiting period until junior creditor can pursue
its remedies against the debtor (60 to 180)
Maximum permitted amount of senior debt.
Is there a cap and if so how much?
What happens if the cap is exceeded?
Any way to prevent cap from being violated?
Right to provide post-bankruptcy financing at
super-priority in bankruptcy, or
higher priority than specified junior lenders
Intercreditor Agreements: Contested Terms
37
Ability of senior lender to change material
terms of debt or charge additional fees
“Call” option by junior lender or “Put” option by
senior lender (requiring purchase of senior
loan at par)
Intercreditor agreements can present special
challenges in subsequent bankruptcy by
debtor
Bankruptcy Risks in Commercial Loan
Modifications 38
Preference claims – focus on timing of payment
to a creditor
Fraudulent transfer claims – focus on amount
paid or other advantage extended to the creditor
and borrower’s financial condition at the time
Loss of lien or priority of lien claims – focus on
proper recording or perfection and trustee
avoidance powers
Equitable subordination claims – focus on
improper conduct by the creditor
Bankruptcy Risk: Preference Claims
[11 USC §547] 39
Bankruptcy specific: avoids payments or transfer
on account of pre-existing debt within 90 days
(creditors generally) and one year (“insiders” to
the debtor as defined in 11 USC §101(31))
Policy: a creditor cannot defeat the general policy
of equal distribution among creditors by seizing or
receiving property of the debtor prior to
bankruptcy
Application: all debtor transfers, including
payments and grants of lien
Bankruptcy Risk: Preference Claims
(continued) 40
Result: transfer avoided and property returned to
estate – leaving creditor to file a claim.
Exceptions:
Transfer for “new value” (“new money’s worth” -
not satisfaction of an old obligation with a new
one)
Example: refinance of old secured loan with
proceeds from new one by third-party refinance
Perfection must occur within 30 days of funding if
transaction to be contemporaneous exchange for
new value
Preference Special Risk Areas
41
Payments/property transfers on account of unsecured debt - risky
Payments/property transfers on account of pre-existing debt - risky
New lien in exchange for old one not accompanied by new debt - risky
New guarantors – NOT a preference since no transfer of principal debtor’s property
Additional Property – risky and likely to be preference if within 90 days prior to bankruptcy filing
Strategy for Preference Avoidance
42
New collateral in exchange for new value
Careful analysis of debtor financial
condition
Prompt perfection of security interest/deed
of trust/mortgage post-closing
Fraudulent Transfers
43
Unlike voidable preferences, fraudulent
transfers exist under both federal bankruptcy
and state law
Federal Bankruptcy: 11 USC §548
Compare Uniform Fraudulent Transfer Act §5
(UFTA) adopted in some form in 43 states,
including California…
…and Florida, see FLA. STAT. §726.105
Types of Fraudulent Transfers (Bankruptcy)
44
Intentional Fraud: for purpose of hindering, delaying, or defrauding creditors
Constructive Fraud: “deemed fraud” based on facts and circumstances indicating that the debtor:
Is “insolvent” [see 11 USC §101(32)], AND
has not received “reasonably equivalent value” in
exchange (based on value of property transferred
compared to value of property received, see In re
TOUSA, Inc., 680 F.3d 1298 (11th Cir. 2012)) , OR
engaged in business for which debtor’s remaining
property was “unreasonably small capital”; OR
intended to incur debts that would be beyond debtor’s
ability to pay.
Fraudulent Transfers: What does “insolvent”
mean? 45
“Insolvent” means, at a given moment in time:
“…financial condition such that the sum of
such entity’s debts is greater than all of such
entity’s property, at a fair valuation,..”
excluding exempt property (under bankruptcy
law) and any property that was fraudulently
transferred.
Note: “fair value” not necessarily book value
under GAAP
Fraudulent Transfers: What does “insolvent”
mean? (continued) 46
Calculation of insolvency includes contingent
liabilities (such as a guaranty obligation), but
at something less than face value.
See In re: Xonics Photochemical, Inc., 841
F.2d 848 (7th Cir. 1988) (Judge Posner
discusses nature and extent of guaranty
obligation for purposes of insolvency)
Fraudulent Transfers: What does “insolvent”
mean? (continued) 47
Additional risk factor – “Equitable Insolvency”
If estate brings state law avoidance action
under 11 U.S.C. § 544(b) and UFTA, bankrupt
estate may try to invoke presumption that
debtor is “equitably insolvent” because of cash
flow inability to pay and thus also insolvent in
the balance sheet sense. See UFTA § 2(b).
In re Gabor, 280 B.R. 149 (Bankr. N.D. Ohio
2002); In re Tri-Star Technologies Co., Inc.,
260 B.R. 319 (Bankr. D. Mass. 2001).
Fraudulent Transfers: What does “insolvent”
mean? (continued) 48
Equitable Insolvency has no parallel in §547 or
§548 of Bankruptcy Code.
Except in case of a municipality, evidence that
debtor not paying debts as they accrue doesn’t
establish that debtor was insolvent under
balance sheet analysis for federal bankruptcy
purposes.
In re Koubourlis, 869 F.2d 1319 (9th Cir.
1989).
Remedy For Fraudulent Transfer/Defenses
49
The exchange is set aside by the bankruptcy
court, and
Transferee must disgorge or pay twice as case
may be.
Transferee Defenses to Fraudulent Transfer
Claim
Gave value and was “in good faith”
Did not know (and should not have known) of
debtor’s insolvency
Why credit underwriting diligence is a two-edged
sword in distressed asset transactions
Hazard Areas for Fraudulent Transfer
Liability 50
Upstream or cross-stream guaranties supported by deed of trust or mortgage (low risk if down-stream)
Deed of trust grantor or mortgagor not receiving loan proceeds
Over-secured deed-in-lieu workouts
New collateral – securing antecedent debt constitutes “value” if securing your own or downstream subsidiary debt
Best Protection Against Fraudulent
Transfer/Preference Liability 51
Wield the two-edged sword deftly:
Thorough analysis of debtor’s financial statements
Updated property appraisals; broker opinons
Structure workout settlement based on the “earmarking”
doctrine” (pre-bankruptcy transfer may not be avoided
as preference or fraudulent conveyance if payment
supplied and “earmarked” for distribution to the creditor
by non-debtor third party)
See Beckerman and Stark, “Structuring Workout
Settlements Premised On The ‘Earmarking’ Doctrine,”
26 Cal. Bankruptcy Journal 2 (2002)
Failure to Record or Perfect Liens Against
Bankruptcy 52
Purely a consideration in bankruptcy
Trustee or DIP in bankruptcy/reorganization case may void unperfected liens under §544(a)(3)
Trustee has rights of a bona fide purchaser from debtor at instant of filing petition and can assert any claims or defenses available to a BFP under applicable state law.
Automatic stay in bankruptcy precludes post-petition filing or perfection by creditor
Frequent foil of landlord lien creditors, unperfected UCC Article 9 secured creditors, and holders of badly drafted or unrecorded deeds of trust or mortgages.
Failure to Record or Perfect Liens Against
Bankruptcy (continued) 53
F. In re Taylor, 422 BR 270 (Bankr. D. Colo.2009): although lender recorded Amended Deed of Trust barely three hours after borrower filed petition in bankruptcy on the same day, correct tax parcel number and street address in prior mortgage constituted “inquiry notice” sufficient to protect lender’s lien and priority position against BFP status of bankruptcy trustee.
G. Compare In re All Star Mortgage, 411 BR 774 (Bankr. S.D. Fla. 2009), bankruptcy trustee is a bona fide purchaser or a subsequent lienholder, without notice, and thus, the trustee's claim to the sale proceeds of estate property is superior to claim by holder of unrecorded mortgage to an equitable lien on the property
Equitable Subordination Claims
54
Generally a bankruptcy matter [see §11 USC
510(c)]
Claim based on allegations of inequitable conduct
by the creditor to the detriment of other creditors:
fraud, illegality, or breach of fiduciary obligation
actions resulting in undercapitalization of the debtor
creditor’s use of debtor as “alter ego”
Likelihood of success on equitable subordination
claim rises as proximity of relationship between
debtor and creditor increases.
Equitable Subordination Claims (continued)
55
Remedy against the creditor is loss of stated lien priority and subordination to other creditors by the bankruptcy court.
In Re Hedged-Investments Associates, Inc. 380 F.3d 1292 (10th Cir. 2004): no equitable subordination of lender’s claim, despite lender's lack of diligence in lending to thinly capitalized corporate debtor operated by its principal as part of Ponzi scheme and similarities between lender's return on its loan and returns promised to investors in Ponzi scheme.
Good discussion of nature of an equitable subordination claim, beginning at 380 F.3d 1300.
Title Insurance: The Creditors' Rights
Exclusion 56
Overview
Summary: importance of creditors’ rights exclusion
History of creditors’ rights exclusions and coverage in the title insurance industry.
Recent underwriter and regulatory developments affecting creditors’ rights exclusion and available endorsements.
Responsibilities and Risks: A Framework for Creditor Analysis
Summary of Creditors Rights Coverage
57
Sustained global recession has increased sensitivity to risks arising from solvency of parties to transactions
Concern manifest in the “creditor’s rights exclusion” in standard ALTA title insurance policy forms.
Preference and fraudulent transfer claims extraordinarily difficult and expensive to defend for a title insurance underwriter:
May involve complete failure of title to the insured estate
Require costly expert witness testimony on value and solvency
Claims are complex and outside normal title insurance underwriting expertise
Summary of Creditors Rights Coverage
(continued) 58
Current ALTA 2006 creditors rights provision found in owners’ and lenders’ coverage and excludes liability to the company for:
Loss or damage arising out of any claim (including a claim to avoid, invalidate, or subordinate a mortgage or deed of trust)
Which arises out of the transaction creating the interest of the insured lender or owner
By reason of federal bankruptcy or state insolvency, or similar creditors’ rights laws
Summary of Creditors Rights Coverage
(continued) 59
Creditors Rights Exclusion precludes claims based on:
Fraudulent transfers under state law or the Bankruptcy Code
Preferential transfers under bankruptcy law
Equitable subordination under bankruptcy law.
Whether asserted against owner or mortgagee
History of Creditors Rights Exclusion
60
1970: ALTA loan policy contained no creditors’
rights exclusion. However, title insurers
argued that creditors’ right claims were
excluded under various preprinted exclusions
found in boilerplate of policy
1990: ALTA Owners and Lenders policies
included first preprinted exclusion for claims
arising out of fraudulent conveyances and
preferential transfers.
History of Creditors Rights Exclusion
(continued) 61
1992: ALTA Owner’s and Lender’s policies still generally excluded claims.
Consumer outcry led to amendment of 1992 ALTA policies to exclude loss of coverage based on title insurer’s failure to timely record documents from creditor’s rights exclusion.
no specific affirmative coverage for creditor’s rights claims was authorized.
In some cases title insurers would delete preprinted creditors’ rights exclusion by endorsement
Specific endorsements extending coverage over creditors’ rights claims were approved by insurance commissioners in some but not all states
History of Creditors Rights Exclusion
(continued) 62
2006: Current ALTA Owner’s and Lender’s policies retain creditors rights exclusion, but provide limited affirmative coverage for creditors’ rights claims.
policies provide coverage for fraudulent or preferential transfers occurring prior to the transaction vesting title in the insured owner or creating the lien of the insured lender.
creditors rights claims arising out of the insured transaction remain expressly excluded; however, currently (and since 1990), no express exclusion for fraudulent or preferential transfers arising in prior transactions (i.e., up the chain of title)
History of Creditors Rights Exclusion
(continued) 63
See Concept Dorssers v. Pacific Northwest
Title Insurance Co., Inc., 2010 WL 1141462
(W.D. Wash. 2010): mortgagee’s claim of
coverage under policy, despite creditors’ rights
exclusion, dismissed based on independent
present fraudulent transfer to mortgagee in
insured transaction; fact that four earlier
transfers in chain of title were also fraudulent
was irrelevant.
History of Creditors Rights Exclusion
(continued) 64
Current Text of Exclusions in ALTA 2006 Owner’s Policy Form:
Owners’ Form – Exclusion #4:
“4. Any claim, by reason of the operation of federal bankruptcy, state insolvency, or similar creditors’ rights laws, that the transaction vesting the Title as shown in Schedule A, is
(a) a fraudulent conveyance or fraudulent transfer; or
(b) a preferential transfer for any reason not stated in Covered Risk 9 of this policy.”
History of Creditors Rights Exclusion
(continued) 65
Lender’s Form – Exclusion #6:
“6. Any claim, by reason of the operation of federal bankruptcy, state insolvency, or similar creditors’ rights laws, that the transaction creating the lien of the Insured Mortgage, is
(a) a fraudulent conveyance or fraudulent transfer, or
(b) a preferential transfer for any reason not stated in Covered Risk 13(b) of this policy.”
The Creditors’ Rights Exclusion: Recent
Developments 66
Prior to 2010: title insurers in some states would authorize use of 1970 ALTA form or state equivalent
ALTA and California Land Title Association (CLTA) promulgated endorsements, offered in many jurisdictions, usually for an additional premium, for “creditors’ rights” coverage – extended coverage over the creditors rights exclusion
Beginning in 2010, most title insurers announced they would not offer any form of creditors’ rights coverage and would not permit agents to offer the 1970 lender policy forms
In some key states, state insurance commissioners announced they would prohibit insurers from offering the coverage
The Creditors’ Rights Exclusion: Recent
Developments
States prohibiting title insurers from providing creditors’ rights coverage:
Florida
New York
New Mexico
Texas
Pennsylvania
Oregon
Ohio
Delaware
New Jersey
ALTA Creditors’ Rights Endorsement 21/21-06 decertified as an
official ALTA Form on March 8, 2010, preceded by CLTA on
February 4, 2010.
67
Responsibilities and Risks: A Framework for
Creditor Analysis 68
In the Post-CRC Era: red flags for creditors’ rights analysis:
new mortgage on borrower property to secure antecedent debt owed to lender or another creditor
mortgage to support up-stream or cross-stream guaranty
mortgage funds used for any purpose other than the purchase of the encumbered real estate: to acquire the stock of another company (e.g., a
leveraged buy out)
to make distributions to an insider, partner or affiliate
to pay debt of an entity other than the borrower.
Responsibilities and Risks: A Framework for
Creditor Analysis 69
Without broader creditors’ rights coverage by title insurers, the risk of credit diligence is transferred to the creditor.
Relevant Questions:
Does any aspect of transaction raise a red flag?
What’s the purpose of the loan and who is receiving the proceeds - paid directly to the transferee, the borrower, or the party pledging its assets)?
Are any of the debtors insolvent in any sense of the term? Will it remain so after the transaction? What financial analysis has been performed on the debtor and by whom?
Responsibilities and Risks: A Framework for
Creditor Analysis 70
Will the transferee remain adequately capitalized
given its business after the transfer?
Is the creditor giving “reasonably equivalent value”
for any lien or property received? Analysis:
What’s the current value of all collateral and how
do we know?
Have appraisals been prepared to substantiate
value and are they current? What else (e.g.,
comparable sales values; brokers opinions of
value)?
Is the creditor under or over secured relative to
value of the collateral?
Other Modification Issues: Mechanics’ Lien
Protection 71
Mechanics' liens related to construction projects
have always presented unique problems for title
insurers and mortgage/deed of trust lenders.
Subprime mortgage loan crisis and financial
meltdown led to many borrower defaults on
commercial real estate financings, and resultant
failed construction projects.
Result: title insurers have also re-evaluated
manner in which they underwrite mechanics’
lien risk.
Other Modification Issues: Mechanics’ Lien
Protection (continued)
Essential Mechanics’ Lien Problem:
Mechanic’s Lien established of record by filing Notice of
Lien or similar document.
But lien priority may date from
date labor or materials first provided to jobsite (NY)
date of filing notice of commencement in public records
(FL)
date judicial action initiated (MD)
If work commenced before issuance of title policy, but lien
is filed after date of policy, title search may not disclose
(and policy won’t reflect) the lien, despite loss of priority of
insured mortgage.
72
Other Modification Issues: Mechanics’ Lien
Protection (continued)
ALTA 2006 owners’ and lenders’ policies include
standard coverage exception for matters not shown
in the public records as existing liens at date of
policy.
Most construction loan policies include “pending
disbursements clause” limiting insured amount and
priority coverage to amount of authorized
disbursements or work performed through date
certain (ALTA Endorsement 32.1-06)
Issue: how do title insurer and lender protect
themselves from mechanics’ lien claims under
various scenarios?
73
Other Modification Issues: Mechanics’ Lien
Protection (continued) 74
1. If Mortgage Recorded Before Work Commences:
Must establish work has not “commenced” under applicable state law (either by title search or by visual inspection of site)
If state law lacks definitive recording to establish commencement of work, borrower indemnity likely to be necessary
“Date-Down Endorsement” on approved state form necessary to maintain priority coverage at each disbursement of loan proceeds .
Coverage increases under loan policy via pending disbursements provision.
Construction loan administration should focus on strict compliance with provisions of state mechanics’ lien law concerning lien waivers and releases as work progresses.
Other Modification Issues: Mechanics’ Lien
Protection (continued)
2. If Mortgage Recorded After Work Commences:
Title insurer will inspect copies of payment applications
and paid invoices/releases for work done to date and
conduct inspection to verify work in place.
Indemnity with full financial statements will be necessary
from borrower, guarantors, principals and contractor.
Same date down endorsement and mechanic lien
administration required as in previous scenario.
Process will be different in states in which
commencement of work established by recording notice
of commencement (stop work for statutory period and
record/serve notice of termination)
75
Other Modification Issues: Mechanics’ Lien
Protection (continued)
3. If Work Stops on Project:
Check to see whether (a) time to record liens has expired,
and (b) no existing or new liens were filed during the notice
period.
Make sure work has completely stopped and record/serve
Notice of Termination or Cessation depending on state law
requirements.
Allow applicable period for Notice of Termination/Cessation
to expire (e.g., 30 days), as well as period for recording
liens (e.g., 60 days).
Don’t re-start construction work until any modification to
the Deed of Trust or Mortgage has been recorded.
Date down endorsement and lien administration as before.
76
Other Modification Issues: Confirming
Existing Guaranties 77
All guarantors must re-affirm continuing, unconditional, joint and several obligations with reference to modification of mortgage or deed of trust, else guarantors may be deemed released.
Important to include recitals establishing that guarantors were fully advised regarding terms of modification of the loan.
Acknowledge that all guaranty provisions remain in full force and effect (except as to any specific amendment).
Include guarantors in insolvency analysis conducted in connection with borrower, especially if guarantors are giving additional security.
Previously subordinate creditors of borrower should be treated in same manner as guarantors.
Other Modification Issues: Adding Collateral
or Guarantors 78
Adding new collateral from borrower, guarantor, or third party: documents should establish that consideration is being given for the new collateral.
Adding new guaranty from affiliated third party: conduct analysis of upstream and downstream guarantor issues. In re TOUSA, Inc., above.
Dealing with revocable estate planning trusts and Illinois land trusts – be careful:
substantiate authority of trustee to act without beneficiary approval
determine existence of sufficient power under trust agreement to execute, delivery, and perform the loan documents
Documentation Strategies: Recordable and
Non-Recordable Documents 79
Documents Typically Recorded:
Amendments changing fundamental business deal between creditor and borrower;
Amendments changing material loan terms (e.g., interest rate, payment stream, real estate collateral, releases);
Documents that affect third party relationships already of record and must give constructive notice to achieve their purposes
Documents Typically Not Recorded
Forbearance agreements not affecting material business terms (i.e., extension of maturity and limited waiver of defaults);
Avoid recording modifications that only affect unrecorded documents (e.g., a note modification agreement)
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