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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 aarostegui@nossaman.com 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

• riginally granted in the loan documents

― The completion by borrower of benchmarks upon which extension

• ptions 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
• riginal (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

• f 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

• r 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 aarostegui@nossaman.com | www.nossaman.com

27

COMMERCIAL MORTGAGE MODIFICATIONS: KEY LEGAL CONSIDERATIONS

David R. Brittain, Esq. 2700 Bank of America Plaza, Tampa, Florida drbrittain@trenam.com

Fundamental Issues

29

 What are the lender’s or borrower’s strategic

• bjectives?

 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

• bligations 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

• n 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

• f 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

• ne)

 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

• f 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

• bligation 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

• f 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

• fficial 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

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 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.

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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?

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Other Modification Issues: Mechanics’ Lien Protection (continued)

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• 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

• f commencement (stop work for statutory period and

record/serve notice of termination)

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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.

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Other Modification Issues: Confirming Existing Guaranties

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 All guarantors must re-affirm continuing, unconditional,

joint and several obligations with reference to modification

• f 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

• r Guarantors

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 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

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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)