Commercial Mortgage Modifications: Lien Priority,...

Commercial Mortgage Modifications: Lien

Priority, Title Insurance and Bankruptcy Issues Structuring Modification Agreements While Avoiding Legal Pitfalls

Today’s faculty features:

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

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.

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.

Sound Quality

If you are listening via your computer speakers, please note that the quality of

your sound will vary depending on the speed and quality of your internet

connection.

If the sound quality is not satisfactory and you are listening via your computer

speakers, you may listen via the phone: dial 1-866-872-6913 and enter your

PIN -when prompted. Otherwise, please send us a chat or e-mail

[email protected] immediately so we can address the problem.

If you dialed in and have any difficulties during the call, press *0 for assistance.

Viewing Quality

To maximize your screen, press the F11 key on your keyboard. To exit full screen,

press the F11 key again.

For CLE purposes, please let us know how many people are listening at your

location by completing each of the following steps:

• In the chat box, type (1) your company name and (2) the number of

attendees at your location

• Click the SEND button beside the box

FOR LIVE EVENT ONLY

If you have not printed the conference materials for this program, please

complete the following steps:

• Click on the + sign next to “Conference Materials” in the middle of the left-

hand column on your screen.

• Click on the tab labeled “Handouts” that appears, and there you will see a

PDF of the slides for today's program.

• Double click on the PDF and a separate page will open.

• Print the slides by clicking on the printer icon.

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


• 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


• 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


• 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


• 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


• 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


• 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


• 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

[email protected]

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


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)



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).



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


(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


(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.


(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


(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)


(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.


(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.”


(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.



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?



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.


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



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


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.



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



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)

Commercial Mortgage Modifications: Lien Priority,...

Documents

Transcript of Commercial Mortgage Modifications: Lien Priority,...